How to take (some of) the stress out of impact investing in frontier markets

TCX, a forex hedging boutique, helped match Lendahand crowdfunding investors with solar developers in Ghana. According to TCX this is the first time that a retail lending platform managed to extend a local currency loan.

TCX, a forex hedging boutique, helped match Lendahand crowdfunding investors with Redavia, a solar energy developer in Ghana. The deal, a €200,000 loan with a two-year tenor, will be denominated in Ghanaian cedis and finances the rollout of zero-carbon energy to Redavia’s corporate clients. Redavia / Lendahand

One of the occupational hazards of impact investing is that it forces you to carry all kinds of risks at a price that doesn’t reflect them.

Few of those risks are more daunting than currency risk, especially given that the countries where many investors most want to have an impact are – almost by definition – those plagued by economic instability, where the value of money can disappear almost overnight.

Currency mismatches kill too much perfectly sound investment. Euro-based investors fear the risk of being repaid in devalued local currency. Borrowers in emerging markets don’t like the risk of being saddled with obligations in hard currency when they only get paid in Nigerian naira or Tanzanian shillings.

Nebulous macroeconomic and political risks that essentially have nothing to do with either borrower or lender slip themselves insidiously between the two, often to the point where one or both sides give up.

This is where a house like Dutch-based hedge provider TCX comes in. Earlier this week, it tied up a deal over two years in the making to bring together clients of Dutch crowdfunding site Lendahand and Redavia, a Ghanaian-based provider of solar energy solutions.

There’s no question TCX or the investments of development finance institutions it is facilitating, is ‘crowding out’ private investment. “We will provide hedging in any emerging market currency as long as there is no one else doing it,” Per van Swaay, TCX's Head of Structuring and Sales, says. TCX

‘First currency hedge for crowd funders’

The deal, a €200,000 loan with a two-year tenor, will be denominated in Ghanaian cedis and will go to finance the rollout of zero-carbon energy to Redavia’s corporate clients.

It’s the first time that a retail lending platform has managed to extend a local currency loan, according to Per van Swaay, TCX’s Head of Structuring and Sales. As a result, Lendahand investors get repaid in euros at an annual rate of 5.5%, and Redavia gets to borrow in cedis.

Lendahand investors are still on the hook for credit risk – the risk that Redavia fails to repay – but they will still be repaid in euros if the cedi devalues sharply in that time.

Likewise, Redavia gets to repay its debt in local currency, even if forces beyond its control make it worthless in the meantime.

Higher currency volatility

Crowdfunding sites are effective magnets for impact investment. They can mobilise retail investor capital more easily without the inertia of a bank and all its internal constraints. But, as van Swaay points out, they simply don’t have the balance sheet strength or the internal risk management skills to handle such complex products.

EMIR, the EU’s European Market Infrastructure Regulation, requires almost all currency derivatives to be collateralised with cash and marked to market daily.

Not without reason: frontier currencies almost always depreciate faster than reserve currencies, due to higher local inflation rates. Over the last ten years, the euro-cedi exchange rate has gone from 2.19 to 7.09.

Volatility across all emerging market currencies has picked up as a result of the pandemic and is likely to stay high: central banks from Brazil to Russia and Turkey – although so far, largely, not in Africa – have had to raise interest rates to defend their currencies as the U.S. Federal Reserve moves closer to a tentative tightening of its monetary policy.

The currency risk for Redavia’s loan is now effectively parked with one of TCX’s shareholders, German development bank Kreditanstalt für Wiederaufbau, one of a handful of European development finance institutions who stand behind TCX.

Filling a market gap

TCX came into existence in 2007 to hedge the foreign exchange risk of European Development Finance Institutions (DFIs), many of whom, like KfW, are forbidden by law from lending in local currency.

A specialist house was necessary because even before the financial crisis of 2008 there were few banks willing to take on such exotic currency risk. The subsequent financial crisis, and the consequent tightening of banking regulation, only made it harder to hedge.

There’s no question here of DFIs ‘crowding out’ private investment. “We will provide hedging in any emerging market currency as long as there is no one else doing it,” Van Swaay told Impact Investor. The result is an illustration of what government can do as an enabler of and multiplier of impact finance.

“We are delighted that we can now offer local-currency loans to our clients,” said Lendahand CEO Koen in the release announcing the deal. “It’s our aim to provide sustainable loans to our customers and this new product allows us to service more businesses who have difficulty getting funding.”